Is the bottom falling out of funding for tech startups?

A discussion on what appears to be the changing investor posture around funding tech startups.

In our article last month on Digicel cancelling its initial public offer (IPO) of stock on the New York Stock Exchange, one of the key reasons given for that decisions was the considerably lower market valuation, and consequently share price, that was likely to eventuate. Had the IPO proceeded, Digicel would have raised far less capital than the USD 2 billion it had hoped, which would have emphasised that the market did not have as much confidence in the firm as the owners did.

Over the past five years or so, tech IPOs have performed well – though not necessarily to the levels of the dotcom era of the 1990s. At relatively recent IPOs, such as those for Facebook, LinkedIn and Twitter, the share price at the end of the first day of trading far exceeded their proposed price range, suggesting that investors were excited about the future of those firms.

However, over the past several months, the market has not been agreeing with firms on how much they are valued. Several firms, such as Etsy, Box and GoPro, which went public earlier this year, and Square and Tinder, earlier this week, all had a lower IPO price than what they were expecting. Could this mean that funding for ICT/tech startups is going into the doldrums?

Potential is not enough

Although at the best of times, investing in businesses is speculative at best, a good guide for the future is past performance. However, in the tech industry, It is not unusual for a firm to be seeking major funding never having broken even, or authoritatively demonstrating viability, but still hoping that investors will buy into the venture (or idea!) that is being presented.

The changing investor attitude and behaviour does suggest that they are no longer as excited about the potential and hype surrounding tech businesses, generally. More importantly, the majority of them that now trade on the NYSE, for example, have been struggling to realise profitability and a return for their shareholders. As a result, there appears to be the sentiment that many tech firms are overvalued in the first place, especially since they have not been meeting investor expectations.

Some tech-related business models still a challenge

WIth the explosion of social media, along with Web 2.0, online products and services tend to be readily available at little or no cost. As a result, many tech businesses have had to adopt business models that focus on building large communities around their offerings, with the hope that those communities can be transitioned into a paying customer base (for premium services), and/or advertisers will be prepared to spend their dollars for access to that community.

However, and as companies such as Facebook and Twitter learned the hard way, having a large subscriber base does not immediately translate into being able to generate enough advertising revenue to move it into profitability. Consequently, and with the benefit of experience and hindsight, investors may be growing increasingly weary of the promise of growth and profitability in a vaguely specified future, which may never materialise.

Implications for the Caribbean

Although situation discussed is based on businesses and the perceived investor environment in the United States, in many instances we, in the Caribbean, tend to be guided by what obtains there. Further, in the region, and among tech startups in particular, it is difficult to get funding. Commercial banks are generally skeptical about financing non-brick-and-mortar businesses, and our private investor communities are either quite small, or non-existent, depending on the country.

It is in light of this that it ought to be appreciated that the more prudent Caribbean investor is likely to consider investor behaviour in other jurisdictions, especially since little industry intelligence is available on the ICT/technology sector in the region. It also means that Caribbean startups ought to be more aware of what appears to be changing investor posture, and be prepared to possibly adjust and adapt accordingly.